Were a hotel's mandatory banquet gratuities of 20% taxable when part was retained by the house and the hotel was not treated as a conventional restaurant?

Subject

Mandatory banquet gratuities up to 20% were exempt

Plain-English summary

Virginia ruled that the hotel's mandatory banquet gratuities were exempt up to 20% of the meal price and ordered a refund of the paid assessment. The statute did not require the entire exempt gratuity to be distributed to employees.

The audit had treated a standard 3% house portion as taxable and then taxed the entire lump-sum 20% charge. The Commissioner rejected that result because the statutory exclusion turned on the percentage of the meal price, not how the hotel divided the collected amount.

The exemption also was not confined to conventional restaurants. Virginia read the restaurant definition and meals regulation to cover hotels and other places where food is served. Only a mandatory gratuity above the 20% statutory limit was taxable.

What this means for you

• Under the historical rule applied here, a mandatory meal gratuity of up to 20% was excluded from sales price.
• The exclusion did not require every dollar to be paid to banquet employees.
• Hotels, caterers, clubs, and other food-service businesses could fall within the meals rule.
• Charges above the statutory percentage limit remained taxable.

Citations and references

• Va. Code §§ 58.1-602 and 35.1-1 9 a; 23 VAC 10-210-930.
• Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-150

Original ruling text

August 27, 2014

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This will reply to your letter in which you seek the correction of a retail sales and use tax assessment issued to * (the "Taxpayer") for the period July 2007 through September 2012. I apologize for the delay in this response.

FACTS

The Taxpayer is a hotel and restaurant management company. The Department audited and assessed the Taxpayer retail sales tax on untaxed mandatory gratuity charges billed to banquet customers. The Taxpayer adds a mandatory 20% gratuity to charges billed for all banquet events. The 20% gratuity amounts are divided among the various employees who work the banquet functions in accordance with a collective bargaining agreement. The gratuity amounts divided among the employees may vary, which can result in the total amount distributed to employees being below or above the 20% gratuity collected from banquet customers. In cases where the gratuity amounts collected from customers exceed the amounts distributed to employees, the Taxpayer reports the excess amount as taxable sales and pays the retail sales and use tax to the Department. The mandatory gratuities distributed to employees are reported as income on Form W-2 for each employee.

DETERMINATION

House Gratuities

The audit staff noted that the 20% mandatory gratuity amounts billed by the Taxpayer included a standard 3% house gratuity. The 3% house gratuity amounts did not appear to be distributed as tips or gratuities to the employees that worked each banquet event. As a result, the house gratuity was deemed to be part of the taxable sales price of the banquet charges billed to customers. Further, the entire 20% gratuity was considered taxable because the taxable 3% gratuity was included in the 20% lump sum gratuity amounts. In accordance with the Department's policy, exempt service charges must be separately stated to qualify for exemption. When customers are billed a lump sum charge that includes exempt and taxable amounts, the entire charge is deemed to be taxable.

For many of the monthly periods included in the audit, the Taxpayer reported on sales tax returns filed with the Department any gratuity amount charges in excess of the gratuity amounts distributed to employees. Credits against the audit liability were allowed in the audit for the gratuity amounts reported to the Department.

The Taxpayer maintains that there is no statutory basis to assess the retail sales tax on mandatory gratuities that do not exceed 20% of the total price charged for banquet events. Virginia Code § 58.1-602 defines "sales price", in part, as:

the total amount for which tangible personal property or services are sold, including any services that are a part of the sale .... "Sales price" shall not include ... v) that portion of the amount paid by the purchaser as a mandatory gratuity or service charge added by a restaurant to the price of a meal, but only to the extent that such mandatory gratuity or service charge does not exceed 20% of the price of the meal.

Based on the language of the exemption statute, I agree that there is no restriction placed on the exemption that requires the full amount of mandatory gratuities billed to purchasers to be distributed to employees or other personnel performing services on behalf of the seller. The statute merely limits the exempt amount of the mandatory gratuity charges to 20% of the price of the meal.

Scope of the Exemption

The audit assessment on the untaxed mandatory gratuity charges was also based on the inclusion of the term "restaurant" in the statutory language for the exemption. The audit staff did not consider the Taxpayer to be a restaurant for purposes of the mandatory gratuity exemption. The Department strictly interprets all sales and use exemptions. If there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Golden Skillet Corp. v. Commonwealth , 214 Va. 276, 199 S.E.2d 511 (1973). Based on the rule of strict construction for exemptions, it was determined that the mandatory gratuity exemption was limited to actual restaurants and did not apply to the Taxpayer. This was also a basis in the audit for assessing the tax on the untaxed mandatory gratuity amounts billed during the audit period by the Taxpayer.

There is no statutory definition of "restaurant" in Title 58.1 of the Virginia Code . However, Va. Code § 35.1-1 9 a defines restaurant, in part, as:

Any place where food is prepared for service to the public on or off the premises, or any place where food is served. Examples of such places include but are not limited to lunchrooms, short order places, cafeterias, coffee shops, cafes, taverns, delicatessens, dining accommodations of public or private clubs, kitchen facilities of hospitals and nursing homes, dining accommodations of public and private schools and colleges, and kitchen areas of local correctional facilities subject to standards adopted under § 53.1-68. (Emphasis added.)

The Department's meals regulation, Title 23 of the Virginia Administrative Code (VAC) 10-210-930 A, interprets the application of the retail sales and use tax to sales of meals and food. Subsection A of the regulation begins with the statement "[r]etail sales of meals by restaurants, hotels, motels, clubs, caterers, cafes and others are taxable." Subsection D of the regulation addresses the application of the tax to gratuities added to the price of meals. The meals regulation is clear that its application is to all types of businesses that sell meals. A wide range of businesses are listed as examples. Likewise, the application of the sales tax to gratuities applies in accordance with the regulation to all types of businesses that sell meals.

It is clear that the definition of restaurant in Va. Code § 35.1-1 9 is intended to include a wide range of businesses that sell and serve meals. The broad application of the Department's tax policy on sales of meals in Title 23 VAC 10-210-930 is consistent with the broad statutory definition of restaurant. Thus, I agree that the mandatory gratuity exemption is not limited to restaurants only but includes any place where food is served. Based on this reasoning, the audit assessment of retail sales tax on the mandatory gratuity amounts billed to customers by the Taxpayer is erroneous. Only in the event that the Taxpayer bills mandatory gratuity charges in excess of the statutory limit of 20% will gratuity charges be taxable. In such cases, the mandatory gratuity charges in excess of the 20% limit are taxable.

CONCLUSION

The Department's records indicate that the Taxpayer has paid contested bill in full. Therefore, a refund of the bill payment of * plus applicable interest, will be issued as soon as practicable.

The Code of Virginia and regulation sections cited, along with other reference documents, are available on line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions concerning this determination, please contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5488078877.S